Wednesday, May 23, 2012

Comment on Krugman on Dimon and Romney (, whatever.)

First, I apologize for being absent for so long; these last weeks have been hectic and tense.

I have a couple of saved up comments though.

A few days ago Paul Krugman wrote an op-ed in the New York Times about the JPMorganChase event. For those who have lived in a cave for the last week, or were shipwrecked or adrift at sea, the bank lost $2 billion by gambling on hard-to-comprehend derivatives recently, and may be on the way to losing even more---all because of exactly the kind of risky behavior that created the financial cataclysm in 2008, and which Jamie Dimon, CEO of JPMorganChase, has been telling us could never happen again because of the exceptional internal risk mitigation strategies that modern banks have implemented. 

Early in the piece, Krugman cited this quote from President Romney---oh, dang.  That can't be right.  I mean Candidate Romney. Anyway, his response was: “This was a loss to shareholders and owners of JPMorgan and that’s the way America works. Some people experienced a loss in this case because of a bad decision. By the way, there was someone who made a gain.”

Krugman takes him to task, explaining that there is risk involved, and some of that risk is guaranteed by taxpayers, so some of those that may lose in these transactions are not consulted in the decisions that created the loss.

All of that is true.  But I think the part about someone else winning what JP Morgan lost needs some additional commentary.  It's not just that the losses at a big bank are guaranteed by the taxpayers, because the risk involved is not only the risk that the invested money will be lost, or that the bet made by the bank will be a losing bet.  Romney is right that every bet has two sides, and every bet by JPMorgan is matched by an opposite bet by someone else.  When the bet is lost, if that is all that happens, then JPMorgan loses and someone else gains an equal amount, and the world as a whole is no worse off.  And the same thing can be said about the taxpayers money: yes, they lose it, but JP Morgan gets the money the taxpayers have lost, so it's a wash for the economy, according to Romney's logic.  And the taxpayers can complain, as implied in the Krugman article, that they weren't the ones who decided to take a risk---but that's not entirely true.  In fact it's not at all true.  They did decide to take those risks.  They, through their representatives in Congress, decided on a policy of lax bank regulation, which is a decision to run exactly the risks that JPMorgan, or Lehman's or AIG took.  They didn't buy the derivatives themselves, but they voted to allow JPMorgan to buy those derivatives with no or little oversight.  If they want to reduce their exposure to that risk, then they should vote for people who will implement strong oversight and strong bank regulation---otherwise, they should expect to take a loss when banker's risks go wrong.

Above I said that someone loses and someone else gains 'if that is all that happens'---but there's a bigger problem with Romney's remark: that is rarely all that happens.  Reaction to massive financial loss is rarely restricted to the person or institution that faced the loss; there are emotional, financial, and economic externalities to very large risks that lose spectacularly.   When the losses occurred in 2008, for example, they helped induce the biggest recession since the great depression.  And the taxpayers are the least of those hurt when financial chaos creates a recession.  When the economy falls off a cliff---even a small cliff, but certainly when it falls into a deep crevasse, as it has for the last few years--- there is a loss that is not made up by anyone else's gain: the decline into recession creates a gap between what the economy could produce, the potential GDP, and the actual recession GDP.  That gap is a dead loss for the country and for the world; it is production and investment that is lost forever.  All of those who become unemployed or underemployed lose enormously.  Those who must put off their life's ambitions, young people who limp financially for their early lives and never recover, or who must drop out of college because they can no longer afford it, lose enormously.  Older people who lose jobs, or lose pensions, lose enormously.  And no one gains.  There is no one on the other side of these risks that has bet the other way.

This is not a zero sum game, as Romney implies.  The sum is never really zero, and in the case of financial chaos the sum can be massively negative.

Next saved comment: recently we heard the name Gordon Gecko on this blog, and in our email chains.  The context in here was more a defense of capitalism as a system than a defense of Gordon Gecko and leveraged buy-outs, but Krugman's blog post on LBOs is very very worth reading.  It's here.

Activities pursued for the sake of self interest can have widely felt beneficial effects, as Adam Smith pointed out.   But greed---that's taking self interest to another level, and it's not at all clear that greed is always good, or even that greed is ever good.

Maybe we'll explore the distinction between self interest and greed in another post. 


  1. Shockingly, in an article the reference for which I've lost, the author noted that a $2B loss for JPMorganChase won't significantly damage the company or hurt future business. American Senator Everett Dirksen was apparently wrong, a billion here or there doesn't mean you are talking about real money, at least not at JPMorganChase.

    (BTW, Dirksen may not have actually said “A billion here, a billion there, and pretty soon you're talking about real money.” but it is a great quote nonetheless.)

    1. True, the $2 billion is not a life-threatening loss for JPMorgan. But it does show that the behavior that Dimon promised us was a thing of the past, the behavior he has been claiming needs no government oversight or regulation because the banks have learned their lesson and can oversee themselves, that behavior is still going on.

      And of course we keep hearing that the loss may be significantly bigger than $2 billion. It won't be big enough to damage JPMorgan, or Jamie Dimon either, but it's hard to argue now that banks are policing themselves. They aren't.